If you want to invest in companies that share your values, consider environmental, social and governance (ESG) funds. They aim to invest in globally environmentally friendly, socially responsible and ethically governed companies. It sounds great, but before you start investing in ESG funds, you will need to address some key risks.
Not all ESGs are the same
Some companies may not live up to the stated ESG principles. An analysis by climate change think tank InfluenceMap found that 71% of ESG equity funds invest in companies that are not up to par when it comes to aligning with the Paris Agreement, a legally binding UN treaty that invites countries to reduce greenhouse gas emissions.
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But that’s not to say there aren’t some gems in the mix. The InfluenceMap study found that the funds analyzed have Portfolio Paris Alignment scores ranging from -42% to + 90%.
ESG funds may also not really be in line with your values. Some highly rated ESG funds may invest in fossil fuel companies. Other component stocks may have solid environmental records, but do not have adequate safety policies in place for their workers.
You need to carefully review ESG funds to make sure they hold companies that reflect your principles. Here are some sources you can use to evaluate ESG funds and the companies they track:
- MSCI ESG Ratings & Climate Search Tool and Sustainalytics Company ESG Risk Ratings Tool: There are no universally recognized ESG rating criteria, but these are two of the most popular ESG rating tools. You can use them to search for companies and examine their ESG track records.
- Ethical Consumer: Founded in 1989, this organization provides free sustainability reports covering more than 40,000 companies, shedding light on controversial or environmentally hazardous business practices.
- The SEC EDGAR website: Here you can search for filing type DEF 14A for different companies to access the proxy statements. The SEC requires companies to file these documents, which present key points for discussion at special shareholders’ meetings. These can give you an idea of changes to boards of directors, directors’ salaries, and other governance information.
- Corporate websites: Explore press release and investor relations pages to see if companies can back up their ESG claims with solid evidence.
- Fund prospectus: In addition to providing crucial information about a fund’s holdings and past performance, you can also use this document to find information about the fund’s objectives and management team.
But even if you can show that an ESG fund or company truly aligns with your values, you can’t forget the fundamentals.
Green funds don’t always go green
Of course, it’s great to support a company that is doing everything it can to protect our planet and its people. But if you’re investing in these companies, you want to make sure they can deliver consistent returns. The ability of ESG funds to do this is not always clear.
A Morning Star (NASDAQ: MORNING) report found that as of June 2022, 65% of US sustainable equity funds were at the bottom of the Morningstar category for year-to-date performance. But this trend may not be directly influenced by the concept of ESG itself. According to the Morningstar report, many ESG funds have a heavy weighting in technology stocks, which have experienced some dips this year. However, ESG funds can also paint a better long-term picture. The same report found that 53% of US equity ESG funds are in the top half of their category over the long term.
Overall, you need to carefully engage in your due diligence when selecting ESG funds. Make sure the companies you invest in truly reflect your values and have the foundation to support reliable performance expectations. For example, you can take a look at the fund’s prospectus online to see its returns over the years.
And if you are not satisfied with these funds, you can always create your own portfolio based on ESG criteria by selecting the ESG stocks of companies that you consider reputable in this space.
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Silly collaborator Javier Simon has no financial position in any of the companies mentioned. The Motley Fool has no position in any of the titles mentioned. The Motley Fool has a disclosure policy.